28JAN09:
Q1-09 DOW: 8900
Q2-09 DOW: 7250
Q3-09 DOW: 5810
Q4-09 DOW: 3960
CITI NATIONALIZED
OBAMA GETS SICK 30SEP08:
31DEC08 INDICES:
FTSE100:3550
DOW30:7550
# HEDGE FUNDS:4425 30JUN08: Oil to be USD200 by 30OCT08 USA Inflation to be 7.5% by 30OCT08
...oops 23APR08:
Next Rights Issue:
HBOS...yes
All & Lec ...
...1 Nil. 17APR08: Oil to be USD127 by 30SEP08
...16MAY08 losing my touch 27FEB08:
2 Banks go bust by 30JUN08
BS down, Lehman (a bit late I know) 20NOV07: Northern Crock to be sold for 15p
Nationalized 01NOV07: Oil to be USD103 EOM
...peaked too soon 08OCT07:
SEC to fine Goldman for pricing issues
...still waiting 15JUN07: ML to buy-out BS
JPM got there first 06JUN07: The Big Crash: 17OCT07
...well it's here
Yesterday's newsletter was shockingly bad. There were typing mistakes, inaccuracies and damn right lies and half truths. The reason is I was distracted by the market turmoil. The liquidity squeeze is causing much pain as unlike Investment Banks who can muster up leverage more easily than us Hedge Funds, we are primarily hostages to Prime Brokers. Having to unwind positions is painful and loss making when all around you are doing the same. However, depression is sometimes hard to shake off but at least I know where I left my Bentley (it is in the garage as usual having some electrical fault corrected).
Market Turmoil distraction is the excuse of the week (man loses car, hedge fund commits fraud, Finbar loses his marbles).
Harvard show us the way, despite some large subprime losses.
Sentinel is the new PlusFunds.
Bonus protection strategies are failing.
US home foreclosures go through the roof.
GLG and Atticus take a pounding.
Market Neutral strategies are back in vogue (cash management especially).
A funny thing happened on the way to freezing the assets of Sentinel Management Group Inc. All but $15.6 million of the $312 million it received from last week's secrecy-enshrouded deal with Citadel Investment Group LLC lit out on a wire, propelled by a US Bankruptcy Court judge to the vigorous applause of, among others, the Commodity Futures Trading Commission and the National Futures Association.
The very same NFA that, after learning of what the US Securities and Exchange Commission charitably characterized as Sentinel's “false and misleading” Aug. 13 letter announcing its suspension of redemptions, wandered over to the firm's offices and found that the company had
...failed to maintain adequate books and records, including records to demonstrate the location of all Seg III Account's assets, and whether or not the account's assets are in any way encumbered.
Or, as the SEC put it:
Sentinel has not kept accurate books and records...necessary to verify the ownership of the securities in its client and 'house' accounts and to prevent the firm from selling assets that it is not entitled to sell and distributing the sale proceed [to] persons not entitled to receive them. [Emphasis added].
Which does raise some interesting questions about who decided who got paid out of the $312 million, who actually got paid, and who decided the basis for the calculation of those payments, some addressed but none satisfactorily answered in the public record so far.
On Monday, Judge John Squires said that Sentinel could immediately pay the proceeds of the Citadel transaction, which according to court documents was concluded in the early morning hours of Aug. 16, with an effective date of Aug. 15, to its clients. Those proceeds had been frozen by a different federal judge on Aug. 17, the day Sentinel filed for bankruptcy.
A filing by Ronald Barliant, one of Sentinel's bankruptcy attorneys, said that the assets sold to Citadel had been custodied in the 'Seg 1' account at the Bank of New York, which had been reluctant to accept Aug. 17 instructions “to wire transfer the proceeds to debtors' clients” in light of temporary restraining orders issued in other courts that day. According to the SEC fraud case, the Seg 1 account contained the assets of registered FCMs with only domestic customer deposits.
According to a Bloomberg report, Daniel Roth, president of NFA—the same NFA that had found Sentinel had failed to keep adequate books and records—said the money to be distributed was from accounts that had been segregated.
“We were strongly in favor of allowing the customer-segregated funds to be distributed.”
Roth said, without explicitly explaining how he came to that conclusion in light of the apparently universal acknowledgement, at least among regulators, that Sentinel's books provide only a vague indication as to the ownership of the its assets.
Also on board with the distribution of the proceeds, according to Bloomberg, citing Robert Trizna, an attorney for Farr Financial Inc, which obtained one of the restraining orders issued Friday:
Trizna claimed that a lawyer for the Commodities Futures Trading Commission told him that, without the disbursements, some futures commission merchants...could fail.
“The judge was faced with the CFTC telling him that it was their understanding that if these distributions weren't made, that as many as 11 futures commission merchants...would fail imminently,” Trizna claimed.
Bloomberg also reported that, according to the court order, “23 different brokerages, including those that had objected to the Citadel sale, will be repaid at various percentages.” As of Tuesday evening, online court records held no documents confirming those facts. Or any other facts explaining why the Seg 1 account was innoculated against Sentinel'ts alleged pandemic of fraud, commingling, misappropriation, misrepresentation, misleading and misfeasance.
Conveniently, however, for the futures industry supervisory bodies, the release of the funds should prevent any nasty clearing house incidents. Especially at the Chicago Mercantile Exchange, which despite publicly confirming that it had no exposure to Sentinel, helped broker the Citadel transaction, according to a report in The Wall Street Journal.
No clearing house incidents, ergo no congressional hearings into how a tiny cash management firm might trigger a little, and it would be little, momentary market mayhem. And that is the important thing.
Your number didn't come up in the lottery? Good luck. According to the SEC, the Bank of New York is going to start liquidating your securities today, and doubtless Sentinel's other counterparties plan similar initiatives. The stone cold certainty is that unravelling Sentinel's machinations will ensure the passage of many a moon before the first installment whatever's left comes your way.
Calls to both the NFA and the CFTC were not returned by pixel time.
Noted with interest: Among the counsel in this fast-metastasizing legal bunfight? Representing Citadel, one Jeff Marwil, restructuring and insolvency partner at Winston & Strawn, Chicago. Better known, certainly on these pixels, as receiver for the Bayou Group.
Fintag says And yet the board of Sentinel was full of lawyers and accountants of many years standing? Why is the American psyche such that when things start going bad, the principals lose the plot. It must be something in the water.
``There's a lot of pessimism out there,'' said Gary Goldstein, chief executive officer of executive-search firm Whitney Group in New York. ``Looking at the world today as we see it and the impact the crunch is likely to have, it looks like bonus pools will decline.''
Bonuses, the financial industry's annual rite of compensation that typically is a multiple of salary, probably will decline as much as 5 percent from 2006, according to Options Group, the New York-based firm that has tracked pay and hiring trends for more than a decade. While the payouts often far exceeded the average of $220,650 at the biggest U.S. securities firms last year and increased as much as 20 percent from 2005, the subprime-mortgage collapse already has drained the punch bowl.
Hardest hit will be employees who create and sell securities backed by mortgages or pools of debt, Options Group said. One out of every three people in those roles may lose their jobs unless business picks up by the end of the year, the firm estimates. Bonuses may fall as much as 40 percent.
Hedge Funds
Hedge-fund investment managers, whose average payout climbed as much as 15 percent last year, may see a drop of 5 percent to 10 percent in 2007. Bonuses for employees in fixed- income units may fall as much as 10 percent, compared with a 10 percent gain last year, Options Group estimates.
Except at the most junior levels, traders and bankers receive most of their annual pay in year-end bonuses that are determined in part by the revenue produced by the individual, their division and the firm as a whole. The average bonus per employee at Wall Street's five biggest firms rose 18 percent in 2006, according to Bloomberg calculations based on company reports.
Individual bonuses vary, with some administrative staff receiving nothing and executives such as Lloyd Blankfein, Goldman Sachs Group Inc.'s CEO, getting more than $50 million on top of his $600,000 salary. Even Blankfein's pay, which is based partly on the firm's operating results and stock performance, may be lower. Goldman's stock, after climbing 56 percent last year, has dropped 12 percent in 2007. Revenue, which gained 49 percent in 2006, rose 11 percent in the first half of 2007.
Lucas van Praag, a Goldman spokesman, said Blankfein wouldn't be available for comment.
Time for Turnaround
Recruiters, who are seeing a pickup in resumes from hedge funds and leveraged buyout firms, cautioned that it's too soon to know what will happen by the time banks start bonus discussions, typically in October. They also note that traders involved in equities, commodities and distressed debt are having a good year and are likely to reap bumper payouts.
``This is the quarter that is going to determine whether compensation is going to be lower or not,'' said Michael Karp, CEO of the Options Group, which bases its estimates on interviews with senior industry executives and information gathered by the firm's network of consultants.
The crisis that started with the mortgage loans to the riskiest borrowers has sent equity and bond prices worldwide on a rollercoaster ride. The market for mortgage-backed securities has dried up, hurting those who trade the bonds or sell them to investors. Investment banks haven't been able to find buyers for leveraged-buyout loans. Prime brokers may see fees drop as some hedge funds close and others reduce borrowing.
Funds that have already shut or failed this year include two credit pools managed by Bear Stearns Cos., UBS AG's Dillon Read Capital Management LLC and Sowood Capital Management LP of Boston.
Resumes Arrive
``We're already seeing a lot of resumes from hedge funds, and we're seeing them at the more junior level, a lot of these kids that defected to hedge funds for more money or a better lifestyle,'' said Deborah Rivera, founder of the Succession Group, a New York-based executive-search and consulting firm. ``We're seeing resumes from private-equity funds that have also let some people go.''
Hedge-fund traders with at least 10 years' experience, who made an average of $580,000 last year, probably will see pay rise 8 percent to 9 percent this year, according to Adam Zoia, founder of New York-based Glocap Search LLC and co-editor-in- chief of the Hedge Fund Compensation Report. That's about half of the rate he was expecting before the market's decline.
``We have just sharply cut our compensation forecasts,'' Zoia said on Aug. 17.
Outsized Paydays
The hedge-fund industry, where assets almost tripled to $1.7 trillion since 2002, leads Wall Street when it comes to outsized paydays. The 25 best-paid hedge-fund managers earned an average of $570 million in 2006, an increase of 57 percent from the previous year, according to Institutional Investor's Alpha magazine. Hedge funds typically charge fees of 1 percent to 2 percent of assets and 20 percent of investment gains.
At the top of Alpha's list was James Simons, founder of East Setauket, New York-based Renaissance Technologies Corp., who was paid an estimated $1.7 billion. Chicago-based Citadel Investment Group LLC's Kenneth Griffin placed second with $1.4 billion. Officials at both firms declined to comment.
Simons's personal profit may drop from 2006 as his biggest fund struggles. The $29 billion Renaissance Equity Opportunities Fund is little changed on the year through last week, according to investors, while last year it returned about 21 percent. Griffin should again rank among the top-paid managers. Citadel, which oversees $15 billion, has returned about 15 percent this year, investors say.
``The ripple effects of hedge funds are more widespread than they've ever been,'' said Robert Discolo, head of hedge- fund strategies at AIG Global Investment Group in New York, which manages more than $8 billion.
Competition for Talent
Big pay packages at hedge funds and leveraged buyout firms have driven compensation higher at Wall Street firms, as they seek to compete for the best traders and bankers. Last year, the five biggest U.S. securities firms paid about $36.5 billion in bonuses, up 32 percent from a year earlier as the number of employees rose 7 percent.
Since last falling in 2002, total bonus payouts at the five firms rose 6 percent in 2003, 19 percent in 2004, and 18 percent in 2005. Securities firms typically set aside about half of their revenue to pay compensation and benefits. Of that, about 60 percent is paid in bonuses at year end.
Recruiters don't expect reductions to be as drastic as they were in the bear market of 2001 and 2002, when the average payout for New York-based securities-industry workers declined 26 percent and 18 percent, according to the state deputy comptroller's office.
Positive Sign
The financial crisis has been profitable for traders who bet mortgage bonds would fall or whose strategies gain amid swings in the markets. One indicator suggests the picture isn't as dire as it was in 2002: Analysts are estimating annual earnings will rise at least 11 percent at the top four Wall Street firms. Bear Stearns, the fifth, is expected to report a drop of about 6 percent.
``The sentiment right now is pretty harsh because in the past two weeks it wasn't hard to see people who lost a lot of money,'' said John, 29, an equity-options trader at a Wall Street bank, who declined to give his last name because he's not authorized to speak to the media. ``But on bonuses, it's too early to say. It was a good market before this, and I don't think people think yet that this will jeopardize pay.''
The bankers who advise LBO firms and the underwriters, salespeople and traders who help create and sell the loans and bonds to finance them are likely to see their rate of pay increases slow, recruiters said.
Bankers Squeezed
Last year, investment bankers saw bonuses jump 20 to 25 percent, the Options Group said. This year the rate of gains for bankers who serve buyout firms will probably slow to 5 percent to 10 percent and could decline further, Options Group said. That's because the banks are having difficulty selling the loans they've already made to finance takeovers and the pace of deals is likely to slow amid higher financing costs.
``The leveraged finance areas are likely to be impacted,'' said Whitney Group's Goldstein.
The success of hedge funds in previous years helped generate demand for prime brokerage, the departments at investment banks that lend to hedge funds and provide them with services such as trading software. Last year, bonuses surged 20 percent to 25 percent in prime brokerage, Options Group estimated. This year they may rise 5 percent to 10 percent, said the Options Group's Karp.
Fintag says The banks need to protect their balance sheets, especially as the real shareholders are annoyed that the banks stock prices have drop so much in recent months.
RICH AND FAMOUS
Harvard's endowment hits $34.9 billion (reuters) Harvard University, already America's richest university, said on Tuesday its endowment grew to a new high of $34.9 billion, boosted by bets on emerging markets, real estate and private equity.
Returns for fiscal 2007, which ended June 30, grew 23 percent, significantly above the 16.7 percent gain posted for 2006 and the 19.2 percent gain reported for 2005.
Harvard, whose investments are closely watched in the asset management industry, also extended its run of beating its internal benchmark and besting the average university's investment returns.
The Ivy League school made headlines last month when it lost $350 million after Sowood Capital, a hedge fund run by a former Harvard employee with whom the university invested, collapsed.
What started with problems in the subprime mortgage market quickly spread and pushed global stock markets lower, hurting many funds, including Sowood.
The school said the Sowood loss would have translated into a decline of about 1 percent on a stand-alone basis.
But the portfolio actually gained 0.4 percent in July because of its positioning and strong risk management. John Longbrake, a university spokesman, declined to say how the portfolio was faring in August, as sharp moves in the yen, metals and stocks left some hedge funds with heavy losses and others able to turn July's declines into gains.
Harvard, unlike many universities, still manages a chunk of its endowment in-house at its Harvard Management Company unit. It also relies on outsiders, including HMC alumni, who have launched their own hedge funds, to invest much of the money donated by former students.
The endowment is not a single fund but roughly 11,000 individual funds, many restricted to specific uses like scientific research or the creation of a professorship, the university said.
Mohamed El-Erian, who replaced Jack Meyer as HMC's president in 2006, is an influential emerging markets bond specialist. And for the second straight year, investments in emerging markets posted the year's highest total return.
Since arriving in Boston, where HMC is located, from California where he worked at Pacific Investment Management Co., El-Erian has rebuilt HMC's depleted staff and implemented other changes. HMC said it restructured the allocations it made to external managers, but gave no details. Looking ahead HMC plans to concentrate on under-exploited market segments to help develop new investment vehicles.
El-Erian said Harvard plans to be more transparent about its structure, activities and governance, setting an example in an industry well-known for its secrecy. Next month, a new Web site will be launched, and in October 2008, HMC will publish its first-ever annual report.
The median large institutional fund returned 17.7 percent in the last fiscal year, according to the Trust Universe Comparison Service.
Harvard, located across the Charles River from Boston in Cambridge, relies heavily on its endowment to cover annual expenses and said it spends about 5 percent of the endowment every year on university programs.
Fintag says ...and some of that money we manage. Well done to Harvard, one of the world's largest fund of funds.
Nice Returns
DETROIT BLUES
US housing foreclosures surged in July - up 93% from July 2006 (finfacts) RealtyTrac, an online marketplace for foreclosure properties, based in Irvine, California, reported on Tuesday that its July 2007 US Foreclosure Market Report, shows that a total of 179,599 foreclosure filings — default notices, auction sale notices and bank repossessions — were reported during the month, up 9 percent from the previous month and up 93 percent from July 2006. The report also shows a national foreclosure rate of one foreclosure filing for every 693 households for the month.
“While 43 states experienced year-over-year increases in foreclosure activity, just five states — California, Florida, Michigan, Ohio and Georgia — accounted for more than half of the nation's total foreclosure filings,” said James J. Saccacio, chief executive officer of RealtyTrac. “Meanwhile, a few states actually reported declining foreclosure activity on a year-over-year basis. Some of these states could be benefiting from increased interest from real estate investors who have pulled out of more volatile markets where home price appreciation seems to have hit its peak for the time being. In contrast, states like Texas, South Carolina and Utah have seen slow but steady price appreciation over the past five years, making them much more attractive and affordable.”
Nevada, Georgia, Michigan post top foreclosure rates Nevada documented the nation's highest state foreclosure rate for the seventh month in a row, one foreclosure filing for every 199 households — more than three times the national average. The state reported a total of 5,116 foreclosure filings during the month, up 8 percent from the previous month and up 215 percent from July 2006.
Georgia's foreclosure rate leapfrogged from eighth highest in June to second highest in July thanks to a 75 percent increase in foreclosure activity from the previous month. The state reported 12,602 foreclosure filings, a 168 percent increase from July 2006 and a foreclosure rate of one foreclosure filing for every 299 households — 2.3 times the national average.
Michigan's foreclosure rate of one foreclosure filing for every 320 households ranked third highest among the states in July, up from seventh highest in June. The state reported 13,979 foreclosure filings during the month, a 39 percent month-over-month increase and a 130 percent year-over-year increase.
Other states with foreclosure rates ranking among the nation's 10 highest in July were California, Colorado, Ohio, Florida, Arizona, Massachusetts and Indiana.
California, Florida, Michigan document largest foreclosure totals California reported 39,013 foreclosure filings in July, the most of any state for the seventh month in a row and up 289 percent from July 2006. The state's foreclosure activity was up less than 1 percent from the previous month, helping its foreclosure rate — one foreclosure filing for every 333 households — slip from second highest to fourth highest among the states.
Despite a 9 percent drop in foreclosure activity over the previous month, Florida continued to document the nation's second highest number of foreclosure filings in July. The state reported 19,179 foreclosure filings during the month, still up 78 percent from July 2006 and a foreclosure rate of one foreclosure filing for every 431 households — seventh highest among the states and 1.6 times the national average.
Michigan replaced Ohio as the state with the third highest number of foreclosure filings, and Ohio dropped to the No. 4 spot despite reporting a 12 percent month-over-month increase in foreclosure activity in July.
Other states with foreclosure filing totals among the nation's 10 highest in July were Georgia, Texas, Colorado, Arizona, Illinois and Nevada.
Detroit posted a 70 percent month-over-month increase in foreclosure activity in July, pushing the city's foreclosure rate to one foreclosure filing for every 97 households — more than seven times the national average and highest among 229 metro areas tracked in the RealtyTrac report. The city reported a total of 8,683 foreclosure filings during the month.
Six California metropolitan areas reported foreclosure rates among the top 10 in July: Stockton at No. 2; Merced at No. 3; Modesto at No. 4; Vallejo-Fairfield at No. 5; Riverside-San Bernardino at No. 8; and Sacramento at No. 9
Other cities with foreclosure rates among the 10 highest were Las Vegas at No. 6, Atlanta at No. 7, and Greeley, Colo., at No. 10.
Fintag says And this is just the beginning. The Bulls may talk about strong fundamentals but they forget to mention that the markets are built on confidence and there is a lot of depression around. This is a good reason why - real people losing their homes and the bankers are to blame.
The Securities and Exchange Commission filed civil fraud charges against Sentinel Management Group, claiming the investment adviser stole clients' money to prop up its own trading accounts. The company, which manages short-term cash for hedge funds, also allegedly used its clients' assets as collateral to leverage its funds without telling them.
In a complaint filed in the US District Court in Chicago, the SEC accused Sentinel of defrauding clients by "improperly commingling, misappropriating and leveraging their securities without their knowledge".
Telegraph - Menswear/Shoes
Sentinel, which managed around $1.2bn (£600m) in assets, helped spook global stock markets last week when it blamed the "liquidity crisis" for putting a freeze on clients redeeming their funds.
"Investor fear has overtaken reason and has induced a period in which most securities have simply ceased to trade," it said.
But the SEC said those statements were "false and misleading".
The SEC alleged that the firm mixed at least $460m of securities from client accounts into one of its own accounts. Some of the clients' securities were also used as collateral for Sentinel to obtain a $321m credit line, on which Sentinel is now in default. Sentinel hid those losses from clients by providing them with misleading account statements, the SEC alleged. Sentinel declined to comment.
Firms such as Sentinel play an important function in the commodities markets by offering short-term cash management to other financial players. Some of its clients are so-called futures clearing firms, institutions that execute a client's trades on an exchange and stand behind the client's obligations.
Other clients include hedge funds.
Last week, to raise cash, Sentinel sold more than $300m of assets to Citadel Investments and those proceeds were placed in an account with Bank of New York.
Yesterday a bankruptcy judge said those proceeds could be distributed to Sentinel's creditors to prevent the failure of any other firm that was relying on them.
During the hearing, Christian Kemnitz, a lawyer representing one of Sentinel's biggest clients, accused the company of "disturbing" and "illegal" behaviour.
"There's more going on here than simple mismanagement," he said.
The National Futures Association, the self-regulator for the futures industry, faulted Sentinel's record-keeping just days before the company went into Chapter 11.
Fintag says What next? They were so distracted that they forgot to eat? Or maybe forgot where they put their top range luxury European motor?
Hedge Fund Manager, Intent on Market, Misses Maserati (bloomberg) ... Bertrand Des Pallieres, founder of the SPQR Capital LLP hedge fund, said he was so focused on the swings in financial markets that he didn't notice his 80,000- pound ($160,000) sports car had been impounded by London authorities...
I WANT MY MUMMY
Welcome Back (breakingviews) Leverage: The end of a summer holiday is rarely a happy moment. But financiers streaming back to their desks in coming weeks may be feeling particularly gloomy. The buyout boom that filled their troughs with fees in the first half of the year has turned from golden goose to albatross. Bankers hoping their year-end bonuses would pay for their month in the Hamptons or Provence may be disappointed.
The big question is what to do about the $330bn or so of debt that banks have promised to stump up for pending buyouts. As demand for leveraged loans has evaporated, the value of these assets has clearly fallen. By how much is not clear.
However, if one assumes the lending institutions sell a chunk of them at a discount, markets others to market prices and hold the remainder on their books, they may be worth 95% of their face value. Even if banks claw back two points of that loss in underwriting fees and interest, this implies a $10bn hit to earnings.
To put that in perspective that's greater than the amount of fees banks and brokers reaped from the buyout business in the go-go months earlier this year. Yet as painful as that may sound, Wall Street may want to take its lumps now and move forward.
Already, banks have stopped writing the sort of iron-clad loan commitment letters to private equity firms that got them in this mess. They now want escape clauses for adverse market changes and more ability to raise interest rates if a loan doesn't sell. Meanwhile, lender-unfriendly structures are a thing of the past. But that won't help them with deals they've already agreed to underwrite.
The reversal in market conditions was brutally fast. As recently as May, bankers bemoaned the need to add an extra half a percent to annual interest payments on a $5.5bn loan for Sam Zell's buyout of Tribune. Looking back, the fact that a heavily indebted borrower in a spiralling industry raised money at 3% over Libor looks like a home run. Compare that with the experience of Chrysler Financial, which only two months later had to price its $4bn loan at 95 cents on the dollar and offer a rate of 4% over Libor.
That five-point discount caused Chrysler's underwriters a loss. And it won't be an isolated incident. Bankers publicly declaim that they won't sell loans at fire-sale prices. But the cost of holding the loans is significant. Regulators force banks to set aside capital representing a big chunk of the value of most loans. Brokers operate under a different regime, but have similar requirements. Even if they only hold an average of 6% of capital against those loans, that would tie up nearly $20bn.
Some mega buyouts, such as those of student lender SLM or Texas utility TXU, may never close, which might be a boon for their lenders. But unless the markets improve significantly, underwriters are likely to end up with a significant pile of unsold debt on their books. And a dwindling appetite from credit-strapped collateralised loan obligations and hedge funds, which absorbed about three-quarters of leveraged loans made earlier this year, makes a strong rebound unlikely.
The industry can cauterise this wound now by biting the bullet, marking down a chunk of their loan exposures and pushing the paper out into the market. The losses this implies would hurt when bonus time comes around. But it would free up capital and remove their exposure to some of the most aggressively leveraged deals seen to date. Taking a painful but manageable hit soon would be better than hoping that one or more of these deals won't implode later, when the actual results of the current credit crunch and housing slowdown may really take their toll.
Fintag says We all know that KKR haven't yet raised the money to fund Boots Alliance, and many more are struggling too. Can only mean one thing - asset stripping, job cuts and Pirates having to get their hands dirty.
After another day of restless anxiety in the world's credit markets, most lenders and investors remained fearful of all but the very safest Treasury securities, and new figures showed that the rate of foreclosures in the housing market in July was almost double that of a year ago.
Analysts now say that the central bank's move last Friday to restore confidence by encouraging banks to borrow directly from the Fed at a lower cost has had only limited impact so far and that the Fed will need to take more drastic action by cutting its benchmark interest rate soon if it fails to see more progress.
“I would calibrate it in days, not weeks,” said Richard Berner, chief United States economist at Morgan Stanley. “If the money markets are still in disarray a few days from now, I would think the Fed is going to have to take additional steps.”
But the central bank's chairman, Ben S. Bernanke, and most other Fed policy makers are extremely reluctant to have the Fed jump to the rescue with an interest rate cut simply to relieve the woes of investors on Wall Street or to bail out hedge funds and others that many blame for the current problems caused by excessive investment in risky mortgages. Instead, the Fed is much more closely watching for clues to whether the housing market itself and consumer spending are weakening before deciding that it needs to cut interest rates.
That means an imminent reduction in the Fed's key policy tool, the federal funds rate on overnight loans between banks, is still far from a sure bet.
The big issue facing the Fed — whether or not to cut the federal funds rate by a quarter point or even half a point from its current level of 5.25 percent and when to do so if it decides a cut is warranted — poses major risks for Mr. Bernanke. Since taking over the Fed in February 2006, Mr. Bernanke's hallmark has been a cool patience and willingness to stick with his economic game plan even when it clashed with the expectations on Wall Street.
But Mr. Bernanke does not have the luxury of time. Lessons from the last big credit crunch, which came after Russia's financial meltdown in August 1998, show that timid action has little effect, while a quick and decisive follow-up move can make a major difference.
On the other hand, any sign that the central bank has itself become overly nervous about the situation by moving precipitously could compound the anxiety that has paralyzed investors about everything from mortgages to commercial bonds.
The Federal Reserve rarely changes its benchmark interest rate between its official policy meetings, and only when it faces an unexpected shock. The last time it did so was a week after the terrorist attacks of Sept. 11, 2001. The Fed's next meeting is not scheduled to occur until Sept. 18.
But the Fed is under time pressure in part because it pointedly raised expectations of a broader rate cut last Friday when it declared that it was “prepared to act as needed” to help the economy weather disruptions in the markets.
The Fed's first move — to entice banks into borrowing through its so-called “discount window” — has done almost nothing to jumpstart lending, many analysts now say.
“It's not clear that the discount window was a viable option,” said Laurence H. Meyer, a former Fed governor who is now vice chairman at Macroeconomic Advisers. “It just doesn't seem like it is going to be a very effective tool in adding liquidity.”
Fed officials and top Treasury officials continued on Tuesday to talk by telephone with major banks, encouraging them to borrow from the discount window and repeating that there was no stigma associated with such loans. Traditionally, banks have only resorted to the Fed's discount window when they had no other place to borrow money.
In a separate move, the Federal Reserve Bank of New York cut in half the fee it charges banks to borrow Treasury securities. Fed officials described the move as “purely technical,” though it dovetailed with investors' rush to find safety in Treasury bills.
Senator Christopher J. Dodd, Democrat of Connecticut and chairman of the banking committee, met with Mr. Bernanke and Treasury Secretary Henry M. Paulson Jr. on Tuesday morning. He said the Fed chairman told him that he would use “all available tools” to head off a surge in mortgage foreclosures.
If Wall Street regains even a small part of its past willingness to finance mortgages and commercial loans, Fed policy makers could gain enough breathing room to postpone a decision until their next scheduled policy meeting.
Fed officials would probably prefer to wait until their Sept. 18 meeting, by which time they will have more information on whether the fear in financial markets has in fact translated to problems in the real economy.
Indeed, there were signs Tuesday of an internal debate about the need to cut rates at all.
Jeffrey M. Lacker, president of the Federal Reserve Bank of Richmond, said in a speech to risk managers in North Carolina on Tuesday that turmoil in financial markets was not a reason in itself to reduce rates.
“Interest rate policy needs to be guided by the outlook for real spending and inflation,” Mr. Lacker said, adding that many of the market's problems are simply a reaction to previous “misjudgments” about the exotic mortgages.
There were hints on Tuesday that such fears, stemming in large part from the meltdown in mortgage markets, were ebbing slightly. The stock market was relatively tranquil for the second day on Tuesday and while investors continued to cling to short-term Treasury bills, a sign of risk aversion, rates moved up later in the day, suggesting that some of those anxieties were easing. And prices of credit swaps tied to Countrywide Financial, the giant but struggling mortgage lender, declined slightly.
But Fed officials had little cause for cheer. Banc of America Securities downgraded the stocks of two major homebuilders — Toll Brothers and Hovnanian Enterprises — because of the growing number of customers canceling contracts for new homes.
And RealtyTrac, a publisher of databases on foreclosures, said on Tuesday that the number of foreclosure filings jumped 9 percent in July, to 179,599, and was 93 percent higher than in July 2006.
More than half of those threatened foreclosures were in California, Florida, Michigan, Ohio and Georgia, RealtyTrac reported. But 43 states experienced an increase in such filings compared with one year ago.
Though many big pending leverage buyouts have run into problems with financing, Fed officials have long been skeptical about the economic impact of such difficulties.
The real issue for policy makers is whether companies are investing less in new equipment and construction, or whether consumer spending is being seriously undermined.
To that end, Mr. Bernanke appears to be paying especially close attention to the health of the housing market. Fed officials have recently acknowledged that the downturn in housing over the last 18 months has been deeper and more protracted than they expected, and the Fed was clearly startled by the recent panic associated with subprime mortgages and other exotic home loans.
Until two weeks ago, Fed officials had steadfastly contended that they saw little spillover from woes in the housing market to the broader economy. And while they had acknowledged acute problems among people with weak credit who took out subprime loans, officials contended that subprime mortgages were a small part of all home loans.
But Fed officials now concede that problems in the mortgage market are broader than they once thought, with problems surfacing in so-called “Alt-A” mortgages, from interest-only loans to “no-doc” loans in which borrowers do not need to document their incomes. Fears about the hidden risks in mortgages have now prompted many investors to back away even from conventional mortgages.
Fed officials were pleasantly surprised earlier this year that the plunge in home building, which began more than a year ago, has not led to higher unemployment or lower consumer spending. But they repeatedly cautioned that uncertainties about housing still posed the biggest risk to their forecast for a “soft landing.”
Fintag says Market intervention is really a sort of market manipulation. It is not good. Who are these investors? As an investor myself, the Fed should leave the markets alone completely. Since they dipped their toes in the markets last Friday, it is no coincidence that they have become much more volatile because nobody has a fcuking clue what they are going to do next.
Once you mix in the contrary ECB and BoJ interest rate decision makers, we have unstable markets. Good for trading but not good for the world economy.
From Hedge Funds To Skype, Collapses Prove Unavoidable (techdirt) Is there a connection between the recent meltdown at quant funds and last week's outage at Skype? Nick Carr makes the provocative argument that both events are the result of what happens when algorithms fail to anticipate behavior that is somehow out of the ordinary. In the case of quant funds, their models failed to anticipate the market's wild volatility, whereas with Skype (if you believe the company's official explanation), the glitch was the result of mass reboots taxing network capacity.
Interestingly, both Skype engineers and hedge fund managers were heard using the phrase "perfect storm" to describe the sequence of events that lead to their respective collapses. Of course, as hedge funds learn every few years, these perfect storms that are mathematically supposed to occur just once in a thousand years, seem to happen quite a bit more often. The same goes for any network that suffers an outage despite the best laid contingency plans. The problem is that it's difficult to craft an algorithm or a model that's robust during 'normal' times and abnormal times. In finance, one hopes that the profits are big enough during the good so that you can survive the occasional mess. The one problem, of course, with the comparison between hedge funds and Skype is that Skype's explanation doesn't ring particularly true. The connection between Microsoft patches, mass reboots and the network collapse seems tenuous at best. Thus, it's entirely possible that this particularly outage had nothing to do with abnormal crowd behavior. Still, as the surprise outage at 365 Main demonstrates, it's difficult, if not fully impossible, to completely inoculate oneself against adverse events.
Fintag says Sorry. My IT geek asked me to review this article. There. Done.
INFLATION
Do not cut rates (ft) Credit fuels the modern economy, and if the dislocation in the money markets lasts another month or two, investment, consumption and growth in the real economy will suffer. Central banks must restore confidence, but rather than cut interest rates they should extend liquidity operations to longer maturities, more collateral and possibly even different counterparties.
Liquidity injections by the Federal Reserve and European Central Bank have brought down overnight interest rates, but longer-term borrowing is still unusually expensive, while US Treasury bills have been trading at panic levels of below 3 per cent. It is hard to borrow using collateral not issued or guaranteed by a government. Central bank intervention has not worked so far.
This is not a recession panic, as in 1998, when the Long-Term Capital Management crisis coincided with weak economic data.
Nor is it a panic caused by serious credit losses. Defaults on US subprime mortgages are miles off a level at which triple-A bonds backed by them would suffer losses. When they do trade, the prices can be reasonable: as part of its acquisition by Kaupthing last week, the Dutch bank NIBC sold its subprime portfolio for 78 cents on the dollar.
The problem is that the bonds do not trade - the crisis is one of liquidity - and that has spread to short-term debt sold by investment vehicles that may be exposed.
The futures market expects the Fed to cut interest rates aggressively, but unless the Fed expects harm to the real economy, that policy makes little sense. It is indiscriminate and so creates moral hazard in the markets, but there is also a good chance it would not work.
The Fed has already pushed its main funds rate down well below its 5.25 per cent target, but the problem is not overnight liquidity at banks, it is perceived credit risk on three-month commercial paper. Giving cheaper money to banks might or might not change that perception.
The lenders of last resort need to find ways to get money through the traditional banking system to the markets where the trouble is. They can do so by agreeing to lend against more securities (the Bank of Canada is already accepting commercial paper); by lending for a few months rather than overnight; and possibly by dealing with off-balance-sheet vehicles directly.
There should be no handouts - lending should be at penalty interest rates - but what is needed to jump-start the credit markets is more targeted liquidity. Central banks should not crack and cut their policy rates while they have more suitable tools in the box.
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